Will Rising Union Activism Expose The Zombified US Pensions

Over the last few years, and at an increasing pace as of more recently, unions have become more and more confident of their ability to effect change and taken much more aggressive activist positionsagainst the capitalist oppressors. The most recent examples range from California cities to Twinkies-maker Hostess Brands, and each time the stance from the unions appears to have been far more aggressive (and M.A.D. prone) than in the past. The question is why? Perhaps, as we tweeted following Hostess' liquidation:

...It is the confidence of an all-powerful government at their back with the US Pension Benefit Guarantee Corporation, which is the backstop for private sector plans, providing cover. The problem is, as UBS explains, the PBGC has a huge deficit and is cashflow negative. This leads us to the uncomfortable expectation of further USD government support (bailout) or a more direct monetization by the Fed. PBGC could be impacted severely if a few large firms terminate their pensions. In this case, UBS expects PBGC to sell equities and buy long duration fixed income.

The Pension Benefit Guarantee Corporation’s (PBGC) 2012 Annual Report reveals significant deterioration in its finances. Our read is that there was very little good news in that report, as most of the PBGC’s key financial viability measures have worsened. Present value of accumulated future benefits jumped due to large declines in interest rates while losses from newly insolvent pensions and probable future insolvencies continued to grow. Specifically,

The $34.4 billion deficit is the highest ever. It has increased $8 billion, or 32%, in the past year (Figure 6).

PBGC remained cashflow negative. Payouts to current pension recipients have outstripped the premium income collected from solvent pensions by $2.75 billion

The 70% funded ratio is the lowest since 2004 and is down from 75% a year ago (Figure 7). PBGC’s own estimate of exposure to “reasonably possible terminations” is $322 billion, i.e. about 2% of the current U.S. GDP

The only major piece of good news was the 12.6% return on PBGC’s investment portfolio.

Fannie, Freddie, PBGC…?

The PBGC might become one of the first public entities to receive a bailout. When the government bailed out Fannie and Freddie it was not legally obligated to keep them afloat, as they were owned by private shareholders. Nonetheless, virtually all investors thought the government would stand behind Fannie and Freddie, and in 2008 they were proven correct. PBGC is a part of the Government. However, in the big picture sense, there is little difference. PBGC, like Fannie and Freddie, is on sound financial footing as long as the US government backs it. The advantage of injecting capital into PBGC is that it becomes more obviously solvent, instead of counting on government support in a crisis. However, its current charter does not allow use of taxpayer funds. Just like its distant cousin FDIC, PBGC’s liabilities are contingent. Taxpayers and legislators probably will not care about PBGC’s or FDIC’s obligations while they are “deep out of the money”. Unfortunately, with the $34 billion deficit that continues to grow, the policy makers will have to start thinking about how to foot the pension protection agency bill, when it comes due.

Strong portfolio return cannot offset low rates and troubled pensions

The 12.6% return in the PBGC investment portfolio in fiscal 2012 was undoubtedly very strong. The resulting $9.8 billion net balance sheet contribution from investments was very significant. That begs the question: why did the funded gap still worsen by $8 billion? One key to the answer lies a little over one mile away from the PBGC headquarters, at the Federal Reserve (Figure 8). As the 2012 annual report indicates, the “actuarial charges due to changes in interest rates” increased $10.8 billion, as “interest factors” decreased by 103 bp. We estimate that PBGC’s liabilities have an average duration of roughly 10.8 years.

We have heard many complaints from private investors, including pensions, about the Fed lowering their liability discounting rates. Operation Twist was joined by QE3 and soon to be followed by QE4. Chairman Bernanke has indicated several times that he is well aware of the pain caused by low yields, but feels convinced that the net benefit from economic recovery will outweigh the potentially short-term problems for pensions. Perhaps PBGC Director Josh Gotbaum will soon take a short walk along the red line in Figure 8 to plead his case with Chairman Bernanke.

Future increases in busted pensions may make PBGC net seller of stocks, buyer of bonds

The market impact from developments at PBGC may be muted in the near-term, but may grow in the future. It runs a very conservative investment portfolio with 2/3 allocated to fixed income. When the agency takes over assets of a busted pension, it is very likely to quickly bring them in line with PBGC’s own portfolio mix. If PBGC has to take over large underfunded pensions, it will likely be a net seller of equities and buyer of bonds. In 2012, PBGC realized roughly $1 billion in losses from taking over 155 terminated pensions with an average funded ratio of 50%. However, that number could have been easily over $10 billion had a single large airline bankruptcy restructuring in 2012 led to termination of its pension plans.

PBGC is part pension, part insurer

The PBGC’s mandate is to protect future incomes for participants in private sector defined benefit pensions. It is essentially a hybrid between a pension fund and an insurance company. In its pension function, PBGC allocates its portfolio of investments to meet future payment obligations to retirees. The insurer side of PBGC collects premia from solvent insured plans and pays out “claims” in the form of current pension payouts. It also must deal with how its capital position is affected by new “claims”, i.e. newly terminated plans and workers going into retirement. PBGC must also consider the capital impact from plans that likely will be taken over soon; in other words, the visible “new claims pipeline”.

Ongoing cash bleed compounds deficit trouble

Two key measures of pension solvency are the funding surplus or deficit and the funding ratio. In PBGC’s case, both of them indicate poor financial health. The deficit is $34 billion (Figure 6 above) and the funded ratio is 70% (Figure 7 above). If PBGC were a traditional corporate pension plan, it almost certainly would be classified as “at-risk”. The insurance side of PBGC also is quite important. Investors often use the ratio of premia to claims in assessing insurers. We apply a similar metric for PBGC: [premiums collected] / [ongoing pension payout]. Figure 9 shows that PBGC was net cashflow negative to the tune of $2.75 billion in 2012 with premiums barely covering 50% of “claim” payments. In fact, the last time premiums exceeded current payouts was in 1999. An entity that has $80 billion in assets, a $34 billion long-term funding shortfall and a significant negative cashflow is not on a sustainable path. No kidding. We doubt anyone expects the PBGC to make money. After all, its role is to mitigate the hits from dodgy pensions. However, the massive deficit and cash outflow put it at risk for a large bailout sooner rather than later.

Pension funding relief passed this summer by Congress does raise the insurance premia that pension sponsors have to pay to PBGC. However, we doubt premium collections will double, which would be required to stop the cash bleed right now. In addition, the new rules focus on high risk funds that have large deficits. Raising insurance premia for these funds could have a perverse effect. Their sponsors may become more likely to terminate the plans and dump them on PBGC, thereby compounding the problem.

Pensions trouble spill over to PBGC within 1-to-2 years

An interesting insight from Figure 6 and Figure 7 is that the PBGC funding gap seems to lag US corporate funding ratios by roughly 1-2 years. For instance, the private pension funding ratio troughed in 2002, while for PBGC the trough came in 2004. Corporate pensions took a huge hit in 2008 during the global credit crisis; for PBGC metrics worsened noticeably in 2009. Finally, the big deterioration in PBGC’s funded ratio and deficit in 2012 may be a delayed reaction to the “pension Waterloo” of 2011. While it is hard to put scientific rigor behind this “lag rule”, we think it does make sense. When corporate pensions take a large hit, it will take some time for companies to get through the reporting cycle. Thus, PBGC has to wait for updated numbers so it can identify new high-risk plans. When a pension is terminated sponsors go through myriad steps. They need to piece together a full picture of the damage, search for solutions to improve things, and finally come to reject all other options before shutting the plan and turning it over to PBGC.

PBGC investment portfolio: good downside hedge but limited upside

PBGC’s current investment portfolio composition is fairly conservative, with a strong tilt to long duration fixed income. Almost 67% of the portfolio is invested in publicly traded bonds, with the largest allocations to U.S. Treasuries and investment grade bonds. Only 28% of the portfolio is in stocks, with the rest split between some private equity/debt and cash. The 10-30bp decline in Treasury yields, outperformance by corporate and EM bonds, and some exposure to equities help explain the 12.6% return on assets in fiscal 2012. With its overweight of government and investment grade corporate bonds the PBGC investment portfolio should act as a good hedge in a risk-off environment. The investment portfolio by itself has limited upside if economic growth accelerates. Nonetheless, in an environment of strong growth and rising interest rates, the declining present value of liabilities should more than offset losses on investments. Interestingly enough, almost 25% of the portfolio is invested in foreign (including emerging market) stocks and bonds. These investments should help diversify portfolio risk, but may prove less liquid and more volatile at the time of stress.

Long term solvency challenged under current framework

We estimate the distribution of PBGC’s funding ratio for various horizons using a Monte Carlo model (Figure 10). We generally use ten years of monthly data to compute the covariance matrix of returns. We use exponential weightings to emphasize more recent observations. For investment grade fixed income we use current yields rather than historical data to project future returns. On the liability side, we project payments using both current data and the trend of average increases in payments over the past five years. We apply the same approach to forecast PBGC’s insurance premia increases.

While we clearly have to make a lot of assumptions, the model’s output should be fairly robust. The historical data are highly transparent, and it is fairly easy to map most of the components of PBGC’s investment portfolio to publicly available indices. In addition, PBGC’s portfolio is very highly diversified, which helps make Monte-Carlo distribution more stable.

The results are quite telling. Thanks to the conservative asset portfolio heavily titled to fixed income, the projected funded ratio is more stable than for most pensions. Stability can be a mixed blessing, as we see little chance that the PBGC will be fully funded in the next 10 years. The downside “tail” scenario could still be painful, as the red bars fall below 50% in later years.

Clear and present danger from large pension bankruptcies

It may take only two or three more large pension bankruptcies to jeopardize PBGC solvency. The American Airlines bankruptcy earlier this year served as a stark reminder that the agency is very exposed to a large underfunded pension going bust. American’s roughly $10 billion funding gap would send PBGC’s deficit soaring. Consequently, the agency pushed back very hard. The airline eventually agreed to freeze, rather than terminate, most of its pension plans. There is no guarantee that PBGC will have the same success in the future.

2012 pension funding relief may lead to growing number of “zombie” pensions

We believe there is another latent threat to the long-term PBGC solvency. We label this peril the “death by a thousand cuts.” As we have discussed in earlier publications, the pension funding relief passed as a part of the highway bill earlier this year has effectively allowed sponsors to cut their contributions to underfunded pensions by nearly 70%. We suspect that in many cases the sponsors’ contributions under the new rule will be lower than the pensions’ ongoing payments to retirees. Again, plans with low initial funding ratios may continue to experience eroding assets, with the government powerless to do anything about it. In some cases, this will become an irreversible path to insolvency, especially for smaller medium size funds that generally stay below the radar screen. One or two extra terminations of mid-size “zombie” pensions probably will not make a big difference to PBGC. However, the PBGC will have to grapple with this issue if the “zombie” numbers mushroom several years down the road.

The issue of PBGC’s solvency is coming to the fore while debates on fiscal policy reach a fever pitch. PBGC’s obligations ultimately fall on the federal government, even though its charter precludes the agency from tapping tax revenues directly. PBGC’s hefty deficit is likely to grow. The agency’s own estimate of loss exposure to “reasonably possible terminations” is $322 billion, i.e. about 2% of the GDP. In the game of over-under, we will take the over. It is ironic, although not that surprising, that a long-term solution to PBGC’s solvency probably would come down to a combination of “revenue raising measures” and “entitlement cuts.” In other words, insurance premia for plan sponsors would rise while the guaranteed portion of pension payments would fall. Without this sort of shift, we think the agency will need a federal bailout.

Bottom line: market impact may be muted for now

The market impact from developments at PBGC may be muted in the near-term, but we expect it to grow. If PBGC takes over a large number of plans, it probably will be a significant seller of equities and buyer of bonds.

We may also see PBGC exert its influence in the market indirectly, through its dialogue with private pensions. It may take a more active role in trying to make plan sponsors improve their funding ratios. Many financially healthy plan sponsors are taking similar steps of their own accord. Consequently, the demand for fixed income could rise, although we have found pensions’ moves very difficult to time.

Ultimately, a sound retirement income system in the U.S. is in the interest of a vast majority of population. Hence, the main pension income insurer needs to be on sound financial footing. However, just as with most other hot public policy topics, we expect a difficult and contentious debate on how to fund or support the PBGC.

That last paragraphs sums it up - its in the favor of the majority and so that will be justification for funding more monetization and implicit bailouts... 2013 may be the year to watch pension fund zombification.

Comment viewing options

Maybe we could just bundle up PBGC, FHA, Fannie, Freddie and the USPS unpayable debt together and call it a AAA bond...sell it to hedge funds with rates like Greek bonds; that appears to be going well.

We could start by cutting back the maximum guarantee from $55k per annum to something like $30k ... maybe the unions would't feel so scorched-earth if their benefits were at risk of being on par with those of a WalMart door greeter's pay.

It's a fine idea, given that we continue to permit our banks to operate despite their current condition, but there's a step you missed.

Banks have to divide the various debts into various grades. The "high-quality" stuff is the stuff they'll sell to Eurozone banks and other financiers, and the low-quality stuff is stuff they keep on the balance sheet so they can claim a high interest rate income from them.

Since our major banks don't have to be solvent, they should be able to fund everything and maintain all the payments forever and ever and ever. Amen.

-----------

EDIT: Awesome to see ZH almost simultaneously published one of the most significant investigative pieces about that...

There was another quote I remembered from that speech, it started with "we face threats to democracy that not even our Constitution can protect us from" that was Greenspan's famous "lament federal immigration policy and its massive economic effects without mentioning immigrants or aliens" speech.

We didn't listen, the GW Bush brain trust stomped on the immigration accelerator and licensed us millions of Obama voters

Japan started with a huge savings pool that has kept them going for 20 years. We don't have nearly those savings. Japan is just now tapped out and left with either printing press or bust. We're already there.

I've been predicting a whole generation retiring into poverty for years. Pension and other benefits are not going to be there. And, when the FED botches things and interest rates and inflation takes off. Boom.

No, no, no. What's to botch? They're going to monetize everything to protect their system of plunder, and other than barter networks, there isn't anything anyone can do about it (short of starting trade networks based on US junk silver coins (which will make you a terrorist)).

The only mechanism to interrupt this destruction is an ALTERNATIVE CURRENCY. Until YOU refuse to accept dollars (euros, etc) in exchange for goods and services this game has no end, as it is an asymptotic approach toward zero value. So far, I've yet to see anyone refuse these notes.

Any entity introducing a competing currency will be invaded in a Libyan minute.

How long did it take Germany to set up a barter system in the 1930s? How long was gold used ininternational trade? An alternative system of some sort will appear immediately. In fact there is probably one being used right now.

>>>WASHINGTON — While current and former executives at bankrupt Hostess Brands, Inc., decide how to spend millions in bonuses, hourly workers are discovering their final paychecks will be short several hundred dollars in promised vacation pay.

According to a bankruptcy-brokered Employee Retention Program at Hostess, workers taking part in the shutdown of Hostess facilities and those workers displaced by the closures will not be paid for vacation time accrued during the previous year. The workers were previously told their earned vacation pay would be included in their final paychecks.

“This is the latest example of how harshly workers are being treated in the Hostess bankruptcy,” said Jim Price, who coordinates activities on behalf of several hundred Hostess employees represented by the International Association of Machinists and Aerospace Workers. “Outrageous payments for Hostess executives are being paid for with outrageous sacrifices from Hostess workers. There is a crying need for balance here.”<<<

The way the government is depending on the taxpayers can only rationally mean that taxpayers are obscenely wealthy, have income streams that will never dry up and have highly trained skills that are always in demand and that they consider taxation an insignificant annoyance. Yeah, that describes about 99% of all Americans. What, me worry?...

The NLRB is still operating with a “recess appointment” that was made when there was no recess. So this will be litigated, providing another chance to overturn everything the NLRB has done since Obama illegally filled the positions.

Christmas came early for Big Labor last week when the National Labor Relations Board handed down a pair of decisions that overturned longstanding precedent and will deliver a windfall to union finances.

On Wednesday, the NLRB voted 3-to-1 to gut protections for workers who don't want their money spent on politics. In states without right-to-work laws, employees of unionized companies are coerced into paying dues as a condition of employment. But under the Supreme Court's 1988 Beck decision, workers are allowed to withhold the portion of their dues that unions spend on political activity.

Unions must also maintain independently verified audits of their finances and provide members with proof that their assertions about spending practices are accurate. But the NLRB now says those requirements no longer apply and so-called Beck objectors are no longer entitled to see proof that their money isn't included in union spending on politics. Maybe the Securities and Exchange Commission should waive business audits too.

"We have to keep an eye on the battle we face—a war on workers. And you see it everywhere there is the Tea Party. And you know there is only one way to beat and win that war. The one thing about working people is we like a good fight. And you know what, they’ve got a war, they’ve got a war with us and there is only going to be one winner. It is going to be the workers of Michigan and America – we are going to win that war. All the way." He then urged the audience to vote in the coming election and in reference to the Tea Party, stated, "Everybody here's got to vote," Hoffa said. "If we go back and we keep the eye on the prize, let's take these sons-of-a-bitches out and give America back to America where we belong!"

With less and less career employment and more on foodstamps and working part-time jobs look for the return of Unions and membership.

I've heard all the anit-union arguments but how much worse would it be than the FED, CONgress, Wall Street, and the Corporatocracy robbing savers and the responsible and laying waste to the middle class?

The bailouts were a clear signal that individuals will be raped to feed the Kleptoligarchy.

Put Jon Corzine behind bars, end the FED, clawback any and all bailout and QE from the banks and corporations that benefitted, and give me 4% or more on my savings, restore the rule of law and individual liberties (right to property, habeus corpus, etc) THEN you may have the moral ground to begin talking about "free markets" and "individual responsibility" and "work ethic".

You can bet your life these pensions will be paid....its a Democratic vote...for life...so add a few hundred more billion to the deficit every year...oh and what politician can vote no on a persons pension..yeah right....the press would fry them...

Look for American and Multi-National Corporations to "come back" to America. Not to produce jobs, but to borrow at a new guaranteed rate and get rewarded for automation.

Look for these multi-nationals to be numb to higher tax rates, as profits rise through automation and the elimination of "small biz competition." Not to mention those businesses who may simply be "not in favor."

Unions are toast. And they'll find little help from their elected officials. The GOP can sit back and relax on this one.

I guess "union activism" is now defined by unions acting against the interests of their members.

What are the "union activists" like Obama pushing?

Higher taxes

Amnesty

Imported subsidized workers

Obamacare

Open borders

Currency debasement

banker bailouts

Seriously, the union leadership should be murdered by their members, they support subsidizing alien scab labor, the absolute worst thing for the interests of 100% their workers, of course that's why leadership has separate fully funded and personally controlled pensions, they know they're "selling their members down the river" just like the plantation owners did 200 years before.

Clinton signed NAFTA into law, and the Dems push for more and more illegal immigration. For the life of me, I cannot understand how the unions continue to throw good money after bad. I'm not suggesting they give it to the Repubs, but damn.... it's like they are paying for their own execution by giving it to Dems. With the added bonus that the Dems are destroying their schools and neighborhoods with their liberalism. Go to any major city that has been run by libs for decades and dare to disagree.

No matter what they do, unions are on the decline for obvious reasons. No way in hell are they coming back in this day and age of globalization. I was in two unions.

What's funny is that here in CA where public salaries are very high the unions demanded the pensions opt out of PBGC & ERISA laws. Why? PBGC limits salary calculations to $250k. Since many public employees make far in excess of $250k (including police and firefighters) they opted out.

Stanford estimates CA public pensions are underfunded by an astonishing $500 BILLION! and no Federal backing.

Chairman Bernanke has indicated several times that he is well aware of the pain caused by low yields, but feels convinced that the net benefit from economic recovery will outweigh the potentially short-term problems for pensions.

What economic recovery? It was supposed to happen in 2010, didn't happen, then 2011, didn't happen then either, then 2012, didn't happen then either. 2013 now? With new taxes and the cost burden of Odumbocare piled on top?

Low yield (read: no yield) is just temporary? When Bennie is saying ZIRP will go thru 2015 (and he will extend it out to 2020 and beyond)?

Hey Bennie, your "until the economy recovers" talk isn't fooling anyone anymore. It isn't going to recover. ZIRP is with us from now on, it will never end, and pension fund yields will be zero from now on.

What will happen? 401k's, IRA's, all private retirement accounts will be confiscated into one huge pool with underwater pension funds, then that pool will be brought into social security

...and the government will loot it dry just like they did with ss trust fund assets.

In her book When I'm Sixty-Four: The Plot against Pensions and the Plan to Save Them, Ghilarducci proposed mandatory participation in a government-run savings plan to which each worker and their employer would supplement their Social Security pension by contributing 2.5 percent each of her or his salary.The plan would be administered by the Social Security Administration, but would be separate from Social Security records. In turn, a refundable tax credit of $600 would go to each participant, regardless of his contributions. The account would have a guaranteed interest rate equal to the government's official inflation rate plus three percent.

Hahahaha because of course the government would never have an incentive to misadjust its own inflation rate...

How can you not love the solutions proposed by economists, aren't they supposed to understand incentives and math? Or perhaps they do understand incentives and realize on which side their bread is buttered, as a real functioning free market economy would have far less need for economists...